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Investment Companies: Closed-end and Open-end - Understanding Net Asset Value and Taxation

This chapter provides important information about closed-end and open-end investment companies, including net asset value (NAV) and taxation. Learn about the advantages offered by funds, sources of return to investors, and different types and styles of investment portfolios.

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Investment Companies: Closed-end and Open-end - Understanding Net Asset Value and Taxation

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  1. Chapter 11 Investment Companies

  2. Investment Companies • Closed-end • Open-end (commonly called a mutual fund)

  3. Important General Information • Net asset value (NAV) - the value of a share • Taxation - pass through vehicles

  4. Advantages Offered by Funds • Diversification • Professional management • Custodial and other services

  5. Closed-end Investment Companies • Fixed capital structure • Shares are bought and sold in the secondary markets • Shares may sell for a premium or discount from NAV • Tendency for shares to sell at a discount from NAV

  6. Discount From Net Asset Value Adams Express $10.75 $12.12 12.8%

  7. Sources of Return to the Investor • Income distributions (dividends) • Capital gains distributions • Appreciation in the NAV • Change in the discount/premium

  8. Real Estate Investment Trust (REIT) • Specialized closed-end investment company • Portfolio of properties and/or mortgages

  9. Unit Trust • Fixed portfolio • Passive investment

  10. Open-end Investment Companies - Mutual Funds • Have a variable capital structure • Shares are bought and sold (redeemed) from the mutual fund • Shares cannot sell for a discount from NAV

  11. The Load Fee • Charged to investor when the shares are purchased • Compensates the sales person • is analogous to brokerage commissions for buying securities

  12. The Load Fee • May vary with dollar amount invested • Load expenses cause investors to pay a premium over the fund's NAV

  13. No-load Mutual Fund • Mutual fund without a sales charge • Other fees and expenses apply

  14. Other Fees and Expenses • Early withdrawal fees (exit fees or reverse load) • Management fees • Operating expenses • 12b-1 fees

  15. Mutual Fund Portfolios • May be classified by • type of investment • investment style

  16. Types of Investments • Growth funds • Balanced funds • Income funds • Growth and income funds • Specialized funds

  17. Specialized Funds • Sector funds • Bond funds • Global funds • International funds • Single country or regional funds • Index Funds

  18. Investment Styles • Large cap • Mid-size cap • Small cap • Growth • Value

  19. Capitalization • Total market value of a company’s stock • Price of the stock times number of shares outstanding

  20. Growth • A strategy designed to identify companies that offer exceptional opportunity for capital appreciation

  21. Value • A strategy designed to identify companies whose stock price appears to be below some estimate of the firm's intrinsic value

  22. Returns Earned by Funds • Advantages do not necessarily include superior returns • Tendency to underperform the market

  23. Selected Aggregate FundReturns 1997 - 2001 Annual Return Growth 8.9% Large-cap 9.4 Small-cap 9.9 Balanced 8.0 International 2.8 S&P 500 10.7

  24. Factors that Affect Investors’ Returns • Expenses • Fees • load fees and exit fees • 12b-1 fees • Movements in the market

  25. Impact of Taxation on Investors • Fund report returns before tax • Shareholders pay applicable taxes • Shareholders realize after-tax returns

  26. Selecting Funds • Low fees and portfolio turnover • Timing of distributions • Tax efficiency

  27. Index Funds and Exchange - Traded Funds (ETFs) • Use of index (e.g. S&P 500) • Diversification - only market risk • Low fees • Low taxes • Cannot outperform the market • Return should mirror the market return

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